Essentials Of Investments
11th Edition
ISBN:9781260013924
Author:Bodie, Zvi, Kane, Alex, MARCUS, Alan J.
Publisher:Bodie, Zvi, Kane, Alex, MARCUS, Alan J.
Chapter1: Investments: Background And Issues
Section: Chapter Questions
Problem 1PS
Related questions
Question
Please answer just part D
![Question
Prob1
Prob2
Prob3
Prob4
Prob5
12-9 NEW PROJECT ANALYSIS You must evaluate a proposal to buy a new milling machine. The
base price is $135,000 and shipping and installation costs would add another $8,000. The
machine falls into the MACRS 3-year class, and it would be sold after 3 years for $94,500.
The applicable depreciation rates are 33%, 45%, 15%, and 7% as discussed in Appendix 12A.
The machine would require a $5,000 increase in net operating working capital (increased
inventory less increased accounts payable). There would be no effect on revenues, but pretax
labor costs would decline by $52,000 per year. The marginal tax rate is 35%, and the WACC
is 8%. Also, the firm spent $4,500 last year investigating the feasibility of using the machine.
a. How should the $4,500 spent last year be handled?
b. What is the initial investment outlay for the machine for capital budgeting purposes,
that is, what is the Year 0 project cash flow?
c. What are the project's annual cash flows during Years 1, 2, and 3?
d. Should the machine be purchased? Explain your answer.](/v2/_next/image?url=https%3A%2F%2Fcontent.bartleby.com%2Fqna-images%2Fquestion%2F96006375-1bc8-4104-8749-d47bd06085f4%2Fc85c0a7d-1489-48d7-9548-c75e1714d468%2F0cj3i0u_processed.jpeg&w=3840&q=75)
Transcribed Image Text:Question
Prob1
Prob2
Prob3
Prob4
Prob5
12-9 NEW PROJECT ANALYSIS You must evaluate a proposal to buy a new milling machine. The
base price is $135,000 and shipping and installation costs would add another $8,000. The
machine falls into the MACRS 3-year class, and it would be sold after 3 years for $94,500.
The applicable depreciation rates are 33%, 45%, 15%, and 7% as discussed in Appendix 12A.
The machine would require a $5,000 increase in net operating working capital (increased
inventory less increased accounts payable). There would be no effect on revenues, but pretax
labor costs would decline by $52,000 per year. The marginal tax rate is 35%, and the WACC
is 8%. Also, the firm spent $4,500 last year investigating the feasibility of using the machine.
a. How should the $4,500 spent last year be handled?
b. What is the initial investment outlay for the machine for capital budgeting purposes,
that is, what is the Year 0 project cash flow?
c. What are the project's annual cash flows during Years 1, 2, and 3?
d. Should the machine be purchased? Explain your answer.
![Step 1
MACRS Depreciation is a method of reduction in book value of tangible fixed assets at an accelerated pace. Most of the value of property,
plant and equipment is depreciated in initial years. Only a certain small amount of depreciation remains for later years.
Step 2 Part a
The amount of $4,500 spent last year on investigation of feasibility of machine should be treated as a period cost and be charged in the
statement of profit and loss of previous year itself. It can't be denominated as a product cost because such cost is not directly or indirectly
related with the production process if such machinery purchasing decision is not made.
Step 3 Part b
The initial investment outlay for the purchase of machinery at time = 0 shall be the purchase price of machinery and the additional
expenditure incurred on it to make it come to a working platform.
Initial Investment Outlay=Purchase Price of Machine + Shipping and installation cos t
=$135, 000 + $8,000
=$143, 000
Step 4 Part c
Particulars
Year 1 ($)
Year 2 ($)
Year 3 ($)
Cost Savings on Labor Costs
52,000
52,000
52,000
Less: increase in operating cash
(5,000)
(5,000)
(5,000)
flows
Less: Depreciation
(16,005)
(21,825)
(7,275)
Net Profit before taxes
30,995
25,175
39,725
Less: Taxes @ 35%
(10,848.25)
(8,811.25)
(13,903.75)
Cash Flows
20,146.75
16,363.75
25,821.25](/v2/_next/image?url=https%3A%2F%2Fcontent.bartleby.com%2Fqna-images%2Fquestion%2F96006375-1bc8-4104-8749-d47bd06085f4%2Fc85c0a7d-1489-48d7-9548-c75e1714d468%2Fyp87zi9_processed.jpeg&w=3840&q=75)
Transcribed Image Text:Step 1
MACRS Depreciation is a method of reduction in book value of tangible fixed assets at an accelerated pace. Most of the value of property,
plant and equipment is depreciated in initial years. Only a certain small amount of depreciation remains for later years.
Step 2 Part a
The amount of $4,500 spent last year on investigation of feasibility of machine should be treated as a period cost and be charged in the
statement of profit and loss of previous year itself. It can't be denominated as a product cost because such cost is not directly or indirectly
related with the production process if such machinery purchasing decision is not made.
Step 3 Part b
The initial investment outlay for the purchase of machinery at time = 0 shall be the purchase price of machinery and the additional
expenditure incurred on it to make it come to a working platform.
Initial Investment Outlay=Purchase Price of Machine + Shipping and installation cos t
=$135, 000 + $8,000
=$143, 000
Step 4 Part c
Particulars
Year 1 ($)
Year 2 ($)
Year 3 ($)
Cost Savings on Labor Costs
52,000
52,000
52,000
Less: increase in operating cash
(5,000)
(5,000)
(5,000)
flows
Less: Depreciation
(16,005)
(21,825)
(7,275)
Net Profit before taxes
30,995
25,175
39,725
Less: Taxes @ 35%
(10,848.25)
(8,811.25)
(13,903.75)
Cash Flows
20,146.75
16,363.75
25,821.25
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